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Posts Tagged ‘Marginal Tax Rate’

I wrote a column for the Wall Street Journal last week about the policy debate over whether it’s better to lower tax rates or to provide targeted tax cuts for parents.

Since this meant I was wading into a fight between so-called reform conservatives (or “reformicons”) and traditional conservatives (or “supply-siders”), I wasn’t surprised to learn that not everyone agreed with my analysis.

James Pethokoukis of the American Enterprise Institute, for instance, doesn’t approve of what I wrote.

…why are some folks on the right against giving middle-class families a big tax cut and letting them keep more of what they earn? …Cato’s Dan Mitchell, in a Wall Street Journal commentary today, concedes Stein’s idea would indeed help middle-class families right now… Yet Mitchell still thinks cutting marginal tax rates is the better idea.

Pethokoukis accurately notes that I want lower marginal tax rates because, from my perspective, faster long-run growth would be even more beneficial to middle-class families.

He disagrees and offers five counter-arguments. Here they are (summarized fairly, I hope), along with my response.

1.) House Ways and Means Chairman Dave Camp has put forward tax reform with a top rate of 25% vs. 40% today. Yet his plan would likely increase the economy’s size by less than 1% over the next decade, according to the Joint Tax Committee. …This is not to say lower tax rates aren’t good for economic growth. But marginal rates at those levels are almost certainly already deep on the good side of the Laffer Curve.

I have a couple of reactions.

First, the top tax rate in the Camp plan is 35 percent rather than 25 percent, so we shouldn’t be surprised that the plan doesn’t generate much additional growth.

Second, the JCT’s model is flawed and it should not be given credibility by any supporter of good tax policy. The Tax Foundation has a much better model.

Though it doesn’t really matter in this case because the Tax Foundation analysis of the Camp plan also shows a very weak growth response, largely because the slightly lower tax rates in the Camp plan are “paid for” by increasing the tax burden on saving and investment. Which is why I also wrote that the plan was disappointing.

Regarding the point about the Laffer Curve, the Tax Foundation responded to the Pethokoukis criticism of my column by noting “the Laffer Curve refers to tax revenue, not economic growth. It says there is a tax rate at which tax revenue is maximized. The tax rate at which economic growth is maximized is almost certainly well below that.”

Needless to say, I fully agree. I want to maximize growth, not tax revenue.

Now let’s move to his second point.

2.) And consider this: just how would the GDP gains, such as they are, from cutting top marginal rates be distributed in an economy where middle-wage jobs are disappearing and income gains are tilted toward the highly skilled and educated? The US economy needs to grow faster, but faster growth alone in the Age of Automation may not substantially increase living standards for a larger swath of the American people. That reality is a big difference between the 2010s economy and the 1980s economy, one many on the right have yet to grasp. Cranking up GDP growth is necessary but not sufficient.

If I understand correctly, Pethokoukis is saying that faster growth doesn’t guarantee good jobs for everyone.

I don’t disagree with this point, but I’m not sure why this is a criticism of lower marginal tax rates. Isn’t it better to get some extra growth rather than no extra growth?

Now let’s address the third point from the Pethokoukis column.

3.) Mitchell asserts, “Tax-credit conservatives generally admit that child-oriented tax cuts have few, if any, pro-growth benefits.” That’s not true. …expanding the child tax credit would serve as a sort of human-capital gains tax cut for worker creators (also known as families). It might just be nudge enough for financially-stressed families to have another kid… Modern pro-growth policymakers should fret as much about the nation’s birthrate as productivity and labor-force participation rates. …A younger American society with a higher birth rate, helped by a tax code that offsets anti-family government policy, would be more dynamic, creative, and entrepreneurial.

I’m less than overwhelmed by this argument.

Yes, we have a demographic problem, but more population is merely a way of increasing total GDP, not per-capita GDP. And it’s the latter than matters if we want higher living standards.

In his fourth point, Pethokouis notes that both supply-siders and reformicons agree on policies to reduce the tax burden on saving and investment.

4.) To give Mitchell some credit here, he does acknowledge there is more to the conservative-reform tax agenda than the child tax credit.

Since we both agree, there’s no need to rebut this part of the column.

And I don’t think there’s anything for me to rebut in Pethokoukis’ final point.

5.) Let me add that there is more to the conservative reform agenda for the middle class than just tax reform, including regulatory, health care, K-12, and higher-education reform. And there should be more to the supply-side, pro-growth agenda than cutting marginal tax rates, including reducing crony capitalist barriers — such as Too Big To Fail megabank subsidies… American needs more growth, and worker creators (strong families) are just as important to achieving that as job creators (strong companies). Let’s have both.

Since I’m among the first to acknowledge that fiscal policy is only about 20 percent of what determines a nation’s prosperity, this is an area where I’m on the same page as Pethokoukis.

Reformicon Founding Fathers

Indeed, I wrote last year that there’s much to admire about the agenda of the reformicons.

I just think that they don’t have sufficient appreciation for the value of even small increases in long-run growth.

Let’s close by looking at one sentence from some supposed analysis by Matt O’Brien in the Wonkblog section of the Washington Post.

His column is dedicated to the proposition that Republicans are overly fixated on cutting taxes for the rich. That might be a defensible hypothesis, but I doubt O’Brien has much credibility since he misrepresents my position.

 Daniel Mitchell of the Cato Institute downplays the idea that giving middle-class families more money even helps them, and says Republicans should keep focusing on cutting tax rates.

Just for the record, here’s what I actually wrote about middle-class families in my WSJ piece.

Child-based tax cuts are an effective way of giving targeted relief to families with children… The more effective policy—at least in the long run—is to boost economic growth so that families have more income in the first place. Even very modest changes in annual growth, if sustained over time, can yield big increases in household income. … If good tax policy simply raised annual growth to 2.5%, it would mean about $4,500 of additional income for the average household within 25 years. This is why the right kind of tax policy is so important. …since more saving and investment will lead to increased productivity, workers will enjoy higher wages, including households with children.

Does any of that sound like I’m indifferent to middle-class families? And the first sentence of that excerpt specifically says that the reformicon approach would mean relief to families with kids.

And the entire focus of my column is that supply-side tax policy would be even more beneficial to those households in the long run.

But accurately reporting what I wrote would have ruined O’Brien’s narrative. Sigh.

P.S. I wrote a couple of days ago that France was is a downward spiral because of high-tax statism. A few people have pointed out that French President Francois Hollande has picked a new industry and economy minister, Emmanuel Macron, who famously said that the new 75 percent top tax rate meant that France was “Cuba without the sun.”

Does this change my opinion, these folks have asked. Doesn’t this signal that taxes will start going down?

The answer is no. At best, I think it simply means that Hollande won’t push policy further to the left. But that doesn’t mean we’ll see genuine liberalization and a reduction in the fiscal burden of government.

If you think I’m being pessimistic, just keep in mind this excerpt from a Bloomberg story.

Macron apologized yesterday for his “exaggerated reputation” for free-market thinking.

I hope I’m wrong, but that doesn’t sound like the words of someone committed to smaller government?

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Obamacare resulted in big increases in the fiscal burden of government (ironically, it would be even worse if Obama hadn’t unilaterally suspended parts of the law).

The legislation increased government spending, mostly for expanded Medicaid and big subsidies for private insurance.

There were also several tax hikes, with targeted levies on medical device makers and tanning beds, as well as some soak-the-rich taxes on upper-income taxpayers.

These various policies are bad news for economic performance, but the damage of Obamacare goes well beyond these provisions.

Writing for Real Clear Markets, Professor Casey Mulligan of the University of Chicago explains that Obamacare contains huge implicit tax hikes on work and other forms of productive behavior.

…can we begin to take seriously the idea that the fiscal policies and regulations hidden in the Affordable Care Act are shrinking our economy? …Politicians and journalists use the term tax more narrowly than economists do, but the economic definition is needed to understand the economic effects of the ACA. …Withholding benefits from people who work or earn is hardly different than telling them to pay a tax. For this reason, economists refer to benefits withheld as “implicit taxes.” What really matters for labor market performance is the reward to working inclusive of implicit taxes, and not the amount of revenue delivered to the government treasury… The ACA…is full of implicit taxes. Many of them have remained hidden in the “fog of controversy” surrounding the law and their effects excluded from economic analyses of it.

In other words, his basic message is that the government reduces incentives to be more productive and earn more money when it provides handouts that are based on people earning less money.

Indeed, click here to see a remarkable chart showing how redistribution programs discourage work.

And speaking of charts, here’s one from Professor Mulligan’s article, and it shows the nation’s largest tax hikes based on what happened to the marginal tax rate on working.

Wow. No wonder we’re suffering from a very anemic recovery.

Professor Mulligan elaborates.

During a period that included more than a dozen tax increases, the ACA is arguably the largest as a single piece of legislation, adding about six percentage points to the marginal tax rate faced, on average, by workers in the economy. The only way to cite larger marginal tax increases would be to combine multiple coincident laws, such as the Revenue Acts of 1950 and 1951 and the new payroll tax rate that went into effect in 1950. Even with these adjustments, the ACA is still the third largest marginal tax rate hike during the seventy years. …Let’s not be surprised that, as we implement a new law that taxes jobs and incomes, we are ending up with fewer jobs and less income.

By the way, other academics also have found that Obamacare will lure many people out of the workforce and into government dependency.

The White House actually wants us to believe this is a good thing, as humorously depicted by this Glenn McCoy cartoon.

But rational people understand that our economic output is a function of how much labor and capital are being productively utilized.

In other words, Obamacare is a mess. It’s hurting the economy and should be repealed as the first step in a long journey back to market-based healthcare.

P.S. Mulligan’s chart also re-confirms that unemployment benefits increase unemployment. Heck, that’s such a simple and obvious concept that it’s easily explained in this Wizard-of-Id parody and this Michael Ramirez cartoon.

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Back in the 1980s and 1990s, there was a widespread consensus that high tax rates were economically misguided. Many Democrats, for instance, supported the 1986 Tax Reform Act that lowered the top tax rate from 50 percent to 28 percent (albeit offset by increased double taxation and more punitive depreciation rules).

And even in the 1990s, many on the left at least paid lip service to the notion that lower tax rates were better for prosperity than higher tax rates. Perhaps that’s because the overwhelming evidence of lower tax rates on the rich leading to higher revenue was fresh in their minds.

The modern left, however, seems completely fixated on class-warfare tax policy. Some of them want higher tax rates even if the government doesn’t collect more revenue!

I’ve already shared a bunch of data and evidence on the importance of low tax rates.

A review of the academic evidence by the Tax Foundation found overwhelming support for the notion that lower tax rates are good for growth.

An economist from Cornell found lower tax rates boost GDP.

Other economists found lower tax rates boost job creation, savings, and output.

Even economists at the Paris-based OECD have determined that high tax rates undermine economic performance.

Today, we’re going to augment this list with some fresh and powerful evidence.

Lots of new evidence. So grab a cup of coffee.

The New York Times, for instance, is noticing that high taxes drive away productive people. At least in France.

Here are some excerpts from a remarkable story.

A year earlier, Mr. Santacruz, who has two degrees in finance, was living in Paris near the Place de la Madeleine, working in a boutique finance firm. He had taken that job after his attempt to start a business in Marseille foundered under a pile of government regulations and a seemingly endless parade of taxes. The episode left him wary of starting any new projects in France. Yet he still hungered to be his own boss. He decided that he would try again. Just not in his own country.

What pushed him over the edge? Taxes, taxes, and more taxes.

…he returned to France to work with a friend’s father to open dental clinics in Marseille. “But the French administration turned it into a herculean effort,” he said. A one-month wait for a license turned into three months, then six. They tried simplifying the corporate structure but were stymied by regulatory hurdles. Hiring was delayed, partly because of social taxes that companies pay on salaries. In France, the share of nonwage costs for employers to fund unemployment benefits, education, health care and pensions is more than 33 percent. In Britain, it is around 20 percent. “Every week, more tax letters would come,” Mr. Santacruz recalled.

Monsieur Santacruz has lots of company.

…France has been losing talented citizens to other countries for decades, but the current exodus of entrepreneurs and young people is happening at a moment when France can ill afford it. The nation has had low-to-stagnant economic growth for the last five years and a generally climbing unemployment rate — now about 11 percent — and analysts warn that it risks sliding into economic sclerosis. …This month, the Chamber of Commerce and Industry of Paris, which represents 800,000 businesses, published a report saying that French executives were more worried than ever that “unemployment and moroseness are pushing young people to leave” the country, bleeding France of energetic workers. As the Pew Research Center put it last year, “no European country is becoming more dispirited and disillusioned faster than France.”

But it’s not just young entrepreneurs. It’s also those who already have achieved some level of success.

Some wealthy businesspeople have also been packing their bags. While entrepreneurs fret about the difficulties of getting a business off the ground, those who have succeeded in doing so say that society stigmatizes financial success. …Hand-wringing articles in French newspapers — including a three-page spread in Le Monde, have examined the implications of “les exilés.” …around 1.6 million of France’s 63 million citizens live outside the country. That is not a huge share, but it is up 60 percent from 2000, according to the Ministry of Foreign Affairs. Thousands are heading to Hong Kong, Mexico City, New York, Shanghai and other cities. About 50,000 French nationals live in Silicon Valley alone. But for the most part, they have fled across the English Channel, just a two-hour Eurostar ride from Paris. Around 350,000 French nationals are now rooted in Britain, about the same population as Nice, France’s fifth-largest city. …Diane Segalen, an executive recruiter for many of France’s biggest companies who recently moved most of her practice, Segalen & Associés, to London from Paris, says the competitiveness gap is easy to see just by reading the newspapers. “In Britain, you read about all the deals going on here,” Ms. Segalen said. “In the French papers, you read about taxes, more taxes, economic problems and the state’s involvement in everything.”

Let’s now check out another story, this time from the pages of the UK-based Daily Mail. We have some more news from France, where another successful French entrepreneur is escaping Monsieur Hollande’s 75 percent tax rate.

François-Henri Pinault, France’s third richest man, is relocating his family to London.  Pinault, the chief executive of Kering, a luxury goods group, has an estimated fortune of £9 billion.  The capital has recently become a popular destination for wealthy French, who are seeking to avoid a 75 per cent supertax introduced by increasingly unpopular Socialist President François Hollande. …It has been claimed that London has become the sixth largest ‘French city’ in the world, with more than 300,000 French people living there.

But it’s not just England. Other high-income French citizens, such as Gerard Depardieu and Bernard Arnault, are escaping to Belgium (which is an absurdly statist nation, but at least doesn’t impose a capital gains tax).

But let’s get back to the story. The billionaire’s actress wife, perhaps having learned from all the opprobrium heaped on Phil Mickelson when he said he might leave California after voters foolishly voted for a class-warfare tax hike, is pretending that taxes are not a motivating factor.

But despite the recent exodus of millionaires from France, Ms Hayek insisted that her family were moving to London for career reasons and not for tax purposes.  …Speaking about the move in an interview with The Times Magazine, the actress said: ‘I want to clarify, it’s not for tax purposes. We are still paying taxes here in France.  ‘We think that London has a lot more to offer than just a better tax situation.

And if you believe that, I have a bridge in Brooklyn that I’m willing to sell for a very good price.

Speaking of New York bridges, let’s go to the other side of Manhattan and cross into New Jersey.

It seems that class-warfare tax policy isn’t working any better in the Garden State than it is in France.

Here are some passages from a story in the Washington Free Beacon.

New Jersey’s high taxes may be costing the state billions of dollars a year in lost revenue as high-earning residents flee, according to a recent study. The study, Exodus on the Parkway, was completed by Regent Atlantic last year… The study shows the state has been steadily losing high-net-worth residents since 2004, when Democratic Gov. Jim McGreevey signed the millionaire’s tax into law. The law raised the state income tax 41 percent on those earning $500,000 or more a year. “The inception of this tax, coupled with New Jersey’s already high property and estate taxes, leaves no mystery about why the term ‘tax migration’ has become a buzzword among state residents and financial, legal, and political professionals,” the study, conducted by Regent states. …tax hikes are driving residents to states with lower tax rates: In 2010 alone, New Jersey lost taxable income of $5.5 billion because residents changed their state of domicile.

No wonder people are moving. New Jersey is one of the most over-taxed jurisdictions in America – and it has a dismal long-run outlook.

And when they move, they take lots of money with them.

“The sad reality is our residents are suffering because politicians talk a good game, but no one is willing to step up to the plate,” Americans for Prosperity New Jersey state director Daryn Iwicki said. The “oppressive tax climate is driving people out.” …One certified public accountant quoted in the study said he lost 95 percent of his high net worth clients. Other tax attorneys report similar results. …Michael Grohman, a tax attorney with Duane Morris, LLP, claimed his wealthy clients are “leaving [New Jersey] as fast as they can.” …If the current trend is not reversed, the consequences could be dire. “Essentially, we’ll find ourselves much like the city of Detroit, broke and without jobs,” Iwicki said.

By the way, make sure you don’t die in New Jersey.

The one bit of good news, for what it’s worth, is that Governor Christie is trying to keep matters from moving further in the wrong direction.

Here’s another interesting bit of evidence. The Wall Street Journal asked the folks at Allied Van Lines where wealthy people are moving. Here’s some of the report on that research.

Spread Sheet asked Allied to determine where wealthy households were moving, based on heavy-weight, high-value moves. According to the data, Texas saw the largest influx of well-heeled households moving into the state last year, consistent with move trends overall. South Carolina and Florida also posted net gains. On the flip side, Illinois and Pennsylvania saw more high-value households move out of state than in, according to the data. California saw the biggest net loss of heavy-weight moves. Last year, California had a net loss of 49,259 people to other states, according to the U.S. Census. …Texas had the highest net gain in terms of domestic migration—113,528 more people moved into the state than out last year, census data show. Job opportunities are home-buyers’ top reason for relocating to Texas, according to a Redfin survey last month of 1,909 customers and website users.

The upshot is that Texas has thumped California, which echoes what I’ve been saying for years.

One can only imagine what will happen over the next few years given the punitive impact of the higher tax rate imposed on the “rich” by spiteful California voters.

If I haven’t totally exhausted your interest in this topic, let’s close by reviewing some of the research included in John Hood’s recent article in Reason.

Over the past three decades, America’s state and local governments have experienced a large and underappreciated divergence. …Some political scientists call it the Big Sort. …Think of it as a vast natural experiment in economic policy. Because states have a lot otherwise in common-cultural values, economic integration, the institutions and actions of the federal government-testing the effects of different economic policies within America can be easier than testing them across countries. …And scholars have been studying the results. …t present our database contains 528 articles published between 1992 and 2013. On balance, their findings offer strong empirical support for the idea that limited government is good for economic progress.

And what do these studies say?

Of the 112 academic studies we found on overall state or local tax burdens, for example, 72 of them-64 percent-showed a negative association with economic performance. Only two studies linked higher overall tax burdens with stronger growth, while the rest yielded mixed or statistically insignificant findings. …There was a negative association between economic growth and higher personal income taxes in 67 percent of the studies. The proportion rose to 74 percent for higher marginal tax rates or tax code progressivity, and 69 percent for higher business or corporate taxes.

Here are some of the specific findings in the academic research.

James Hines of the University of Michigan found that “state taxes significantly influence the pattern of foreign direct investment in the U.S.” A 1 percent change in the tax rate was associated with an 8 percent change in the share of manufacturing investment from taxed investors. Another study, published in Public Finance Review in 2004, zeroed in on counties that lie along state borders. …Studying 30 years of data, the authors concluded that states that raised their income tax rates more than their neighbors had significantly slower growth rates in per-capita income. …economists Brian Goff, Alex Lebedinsky, and Stephen Lile of Western Kentucky University grouped pairs of states together based on common characteristics of geography and culture. …Writing in the April 2011 issue of Contemporary Economic Policy, the authors found “strong support for the idea that lower tax burdens tend to lead to higher levels of economic growth.”

By the way, even though this post is about tax policy, I can’t resist sharing some of Hood’s analysis of the impact of government spending.

Of the 43 studies testing the relationship between total state or local spending and economic growth, only five concluded that it was positive. Sixteen studies found that higher state spending was associated with weaker economic growth; the other 22 were inconclusive. …a few Keynesian bitter-enders insist that transfer programs such as Medicaid boost the economy via multiplier effects… Nearly three-quarters of the relevant studies found that welfare, health care subsidies, and other transfer spending are bad for economic growth.

And as I’ve repeatedly noted, it’s important to have good policy in all regards. And Hood shares some important data showing that laissez-faire states out-perform their neighbors.

…economists Lauren Heller and Frank Stephenson of Berry College used the Fraser Institute’s Economic Freedom of North America index to explore state economic growth from 1981 to 2009. They found that if a state adopted fiscal and regulatory policies sufficient to improve its economic freedom score by one point, it could expect unemployment to drop by 1.3 percentage points and labor-force participation to rise by 1.9 percentage points by the end of the period studied.

If you’ve made it this far, you deserve a reward. We have some amusing cartoons on class-warfare tax policy here, here, here, here, here, here, and here.

And here’s a funny bit from Penn and Teller on class warfare.

P.S. Higher tax rates also encourage corruption.

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On several occasions, I’ve observed that the poverty rate in America was steadily falling, but that progress came to a halt in the mid-1960s when the government declared a War on Poverty.

And I almost always included a chart showing the annual poverty rate over several decades.

Moreover, I posted graphs showing how government programs trap people in dependency because of very high implicit marginal tax rates. And that’s true in other nations as well.

But it didn’t matter how many times I revisited this issue, I was never clever enough to look at the poverty-rate data to estimate what would have happened if the federal government hadn’t become involved.

Fortunately, John Goodman of the National Center for Policy Analysis was insightful enough to fill the breach. He shows that the War on Poverty has made a big difference. But in the wrong way.

Poverty Goodman

Here’s some of what John wrote about the topic in a column for Forbes.

From the end of World War II until 1964 the poverty rate in this country was cut in half. Further, 94% of the change in the poverty rate over this period can be explained by changes in per capita income alone. Economic growth is clearly the most effective antipoverty weapon ever devised by man. The dotted line shows what would have happened had this trend continued. Economic growth would have reduced the number in poverty to a mere 1.4% of the population today—a number so low that private charity could probably have taken care of any unmet needs. …we didn’t continue the trend. In 1965 we launched a War on Poverty. And as the graph shows, in the years that followed the portion of Americans living in poverty barely budged.

John augments this analysis by looking at some of the social science research about poverty and government dependency.

The numbers are very depressing.

…here is something you may not know. Early on ― in the first decade of our 50-year experiment with an expanded welfare state ― carefully controlled experiments funded by the federal government established without question that welfare changes behavior. It leads to the very behavioral changes that keep people in a state of poverty and dependency. …The experiments were all conducted by social scientists who believed in the welfare state and had no doubt about its capacity to be successful. …The experiments were all controlled. Randomly selected people were assigned to a “control group” and an “experimental group.” …the results were not pretty. To the dismay of the researchers, they largely confirmed what conventional wisdom had thought all along. …The number of hours worked dropped 9% for husbands and 20% for wives, relative to the control group. For young male adults it dropped 43% more. The length of unemployment increased 27% among husbands and 42% for wives, relative to the control group. For single female heads of households it increased 60% more. Divorce increased 36% more among whites and 42% more among blacks. (In a New Jersey experiment, the divorce rate was 84% higher among Hispanics.)

President Obama and other folks on the left don’t seem overly interested in this data.

Instead, they beat the drums about class warfare and income inequality.

They want us to believe the economy is a fixed pie and that all of us somehow get less if some entrepreneur becomes rich.

But John’s point from the column is correct. Economic growth is the way to help the poor, not redistribution.

Unfortunately, many politicians are hostile to the types of policies that produce more growth. Maybe it’s because they don’t understand economics. Or maybe they understand economics but don’t care because they think they’ll be more successful at the ballot box if they pursue the politics of envy and division.

But regardless of motive, bigger government doesn’t have good results, as illustrated by this Gary Varvel cartoon.

Political Cartoons by Gary Varvel

This Chip Bok cartoon, featuring Obama with his ideological soulmate, also is worth sharing.

Political Cartoons by Chip Bok

P.S. Margaret Thatcher has the best-ever takedown of the left’s inequality agenda.

P.P.S. If you want to get agitated, click here to see how a bureaucracy in Paris is using American tax dollars to push a crazy new definition of poverty. Why? To promote more redistribution.

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The title of this piece has an asterisk because, unfortunately, we’re not talking about progress on the Laffer Curve in the United States.

Instead, we’re discussing today how lawmakers in other nations are beginning to recognize that it’s absurdly inaccurate to predict the revenue impact of changes in tax rates without also trying to measure what happens to taxable income (if you want a short tutorial on the Laffer Curve, click here).

But I’m a firm believer that policies in other nations (for better or worse) are a very persuasive form of real-world evidence. Simply stated, if you’re trying to convince a politician that a certain policy is worth pursuing, you’ll have a much greater chance of success if you can point to tangible examples of how it has been successful.

That’s why I cite Hong Kong and Singapore as examples of why free markets and small government are the best recipe for prosperity. It’s also why I use nations such as New Zealand, Canada, and Estonia when arguing for a lower burden of government spending.

And it’s why I’m quite encouraged that even the squishy Tory-Liberal coalition government in the United Kingdom has begun to acknowledge that the Laffer Curve should be part of the analysis when making major changes in taxation.

UK Laffer CurveI don’t know whether that’s because they learned a lesson from the disastrous failure of Gordon Brown’s class-warfare tax hike, or whether they feel they should do something good to compensate for bad tax policies they’re pursuing in other areas, but I’m not going to quibble when politicians finally begin to move in the right direction.

The Wall Street Journal opines that this is a very worthwhile development.

Chancellor of the Exchequer George Osborne has cut Britain’s corporate tax rate to 22% from 28% since taking office in 2010, with a further cut to 20% due in 2015. On paper, these tax cuts were predicted to “cost” Her Majesty’s Treasury some £7.8 billion a year when fully phased in. But Mr. Osborne asked his department to figure out how much additional revenue would be generated by the higher investment, wages and productivity made possible by leaving that money in private hands.

By the way, I can’t resist a bit of nit-picking at this point. The increases in investment, wages, and productivity all occur because the marginal corporate tax rate is reduced, not because more money is in private hands.

I’m all in favor of leaving more money in private hands, but you get more growth when you change relative prices to make productive behavior more rewarding. And this happens when you reduce the tax code’s penalty on work compared to leisure and when you lower the tax on saving and investment compared to consumption.

The Wall Street Journal obviously understands this and was simply trying to avoid wordiness, so this is a friendly amendment rather than a criticism.

Anyhow, back to the editorial. The WSJ notes that the lower corporate tax rate in the United Kingdom is expected to lose far less revenue than was predicted by static estimates.

The Treasury’s answer in a report this week is that extra growth and changed business behavior will likely recoup 45%-60% of that revenue. The report says that even that amount is almost certainly understated, since Treasury didn’t attempt to model the effects of the lower rate on increased foreign investment or other “spillover benefits.”

And maybe this more sensible approach eventually will spread to the United States.

…the results are especially notable because the U.K. Treasury gnomes are typically as bound by static-revenue accounting as are the American tax scorers at Congress’s Joint Tax Committee. While the British rate cut is sizable, the U.S. has even more room to climb down the Laffer Curve because the top corporate rate is 35%, plus what the states add—9.x% in benighted Illinois, for example. This means the revenue feedback effects from a rate cut would be even more substantial.

The WSJ says America’s corporate tax rate should be lowered, and there’s no question that should be a priority since the United States now has the least competitive corporate tax system in the developed world (and we rank a lowly 94 out of the world’s top 100 nations).

But the logic of the Laffer Curve also explains why we should lower personal tax rates. But it’s not just curmudgeonly libertarians who are making this argument.

Writing in London’s City AM, Allister Heath points out that even John Maynard Keynes very clearly recognized a Laffer Curve constraint on excessive taxation.

Supply-side economist?!?

Even Keynes himself accepted this. Like many other economists throughout the ages, he understood and agreed with the principles that underpinned what eventually came to be known as the Laffer curve: that above a certain rate, hiking taxes further can actually lead to a fall in income, and cutting tax rates can actually lead to increased revenues.Writing in 1933, Keynes said that under certain circumstances “taxation may be so high as to defeat its object… given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more—and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.”

For what it’s worth, Keynes also thought that it would be a mistake to let government get too large, having written that “25 percent [of GDP] as the maximum tolerable proportion of taxation.”

But let’s stay on message and re-focus our attention on the Laffer Curve. Amazingly, it appears that even a few of our French friends are coming around on this issue.

Here are some passages from a report from the Paris-based Institute for Research in Economic and Fiscal Issues.

In an interview given to the newspaper Les Echos on November 18th, French Prime Minister Jean -Marc Ayrault finally understood that “the French tax system has become very complex, almost unreadable, and the French often do not understand its logic or are not convinced that what they are paying is fair and that this system is efficient.” …The Government was seriously disappointed when knowing that a shortfall of over 10 billion euros is expected in late 2013 according to calculations by the National Assembly. …In fact, we have probably reached a threshold where taxation no longer brings in enough money to the Government because taxes weigh too much on production and growth.

This is a point that has also been acknowledged by France’s state auditor. And even a member of the traditionally statist European Commission felt compelled to warn that French taxes had reached the point whether they “destroy growth and handicap the creation of jobs.”

But don’t hold your breath waiting for good reforms in France. I fear the current French government is too ideologically fixated on punishing the rich to make a shift toward more sensible tax policy.

P.S. The strongest single piece of evidence for the Laffer Curve is what happened to tax collections from the rich in the 1980s. The top tax rate dropped from 70 percent to 28 percent, leading many statists to complain that the wealthy wouldn’t pay enough and that the government would be starved of revenue. To put it mildly, they were wildly wrong.

I cite that example, as well as other pieces of evidence, in this video.

P.P.S. And if you want to understand specifically why class-warfare tax policy is so likely to fail, this post explains why it’s a fool’s game to target upper-income taxpayers since they have considerable control over the timing, level, and composition of their income.

P.P.P.S. Above all else, never forget that the goal should be to maximize growth rather than revenues. That’s because we want small government. But even for those that don’t want small government, you don’t want to be near the revenue-maximizing point of the Laffer Curve since that implies significant economic damage per every dollar collected.

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Obamacare was put together by people who don’t understand economics.

This is probably the understatement of the year since I could be referring to many features of the bad law.

The higher tax burden on saving and investment, making an anti-growth tax system even worse.

The exacerbation of the third-party payer problem, which is the nation’s biggest healthcare problem.

The increased burden of government spending, worsening America’s entitlement crisis.

Those are all significant problems, but today I want to focus on how Obamacare encourages people to be less productive. And I’m going to use a rather unexpected source. The left-leaning San Francisco Chronicle has a financial advice column that inadvertently show how Obamacare discourages people from earning income.

The article nonchalantly explains that people may want to reduce their income so they can get more goodies from the government.

People whose 2014 income will be a little too high to get subsidized health insurance from Covered California next year should start thinking now about ways to lower it to increase their odds of getting the valuable tax subsidy. “If they can adjust (their income), they should,” says Karen Pollitz, a senior fellow with the Kaiser Family Foundation. “It’s not cheating, it’s allowed.” Under the Affordable Care Act, if your 2014 income is between 138 and 400 percent of poverty level for your household size, you can purchase health insurance on a state-run exchange (such as Covered California) and receive a federal tax subsidy to offset all or part of your premium. …getting below the 400 percent poverty limit could save many thousands of dollars per year.

You may be thinking that this is just a theoretical problem, but the article cites a very real example.

To get a subsidy, the couple’s modified adjusted gross income for 2014 income would need to fall below $62,040, which is 400 percent of poverty for a family of two. …Proctor estimates that her 2014 household income will be $64,000, about $2,000 over the limit. If she and her husband could reduce their income to $62,000, they could get a tax subsidy of $1,207 per month to offset the purchase of health care on Covered California. That would reduce the price of a Kaiser Permanente bronze-level plan, similar to the replacement policy she was quoted, to $94 per month from $1,302 per month. Instead of paying more than $15,000 per year, the couple would pay about $1,100.

To put it in even simpler terms, this couple has figured out that they can get almost $14,000 of other people’s money by reducing how much they earn by just $2,000.

That, in a nutshell, is the perfect illustration of the welfare state. It tells people that they can get more by producing less. And the system is based on the theory that there will always be some suckers who work hard to provide the subsidies.

But as we’ve seen in Greece, Italy, Spain, and elsewhere, this system eventually breaks down as more and more people learn that it’s easier to ride in the wagon than it is to pull the wagon (as powerfully illustrated by these two cartoons).

And remember that the United States isn’t too far behind Europe’s welfare states.

Thanks to the plethora of welfare programs and income-redistribution schemes that already exist, millions of Americans have an incentive to earn less money and get trapped in government dependency. This graph, for instance, shows that various handouts mean that a single mom with $29,000 of income can be better off than a self-reliant person with $69,000 of income.

And a local CBS station discovered that a low-income household could be eligible for more than $80,000 of goodies from the government. Earning more money, though, would mean fewer handouts.

The same problem exists, by the way, in other nations such as Denmark and the the United Kingdom.

Remember Julia, the mythical moocher created by the Obama campaign to show the joys of government dependency? As illustrated by this Ramirez cartoon, Julia symbolizes the entitlement mentality. But the cartoon doesn’t go far enough. It should show how Julia decides to lead a less productive and less fulfilling life because she gets hooked on the heroin of handouts.

P.S. Some honest liberals recognize that redistribution can trap people in poverty.

P.P.S. Unsurprisingly, Thomas Sowell explains this issue with blunt and powerful logic.

P.P.P.S. To close with some humor, here’s a new Declaration of Dependency put together for our leftist friends. Though they may want to think twice before asking for a divorce from Red State America.

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I periodically cite new academic research about tax policy and economic activity. I sometimes even publicize research from international bureaucracies showing the link between taxes and growth.

I’m not naive enough to think that any particular study will change minds, but when the bulk of the research unambiguously tells us that lower tax rates are better for economic performance, I think (or at least hope) that it may have some impact on government officials.

Which is why I’m particularly interested in some new research by Professor Karel Mertens from Cornell University.

Here are some key findings from Professor Mertens’ study, beginning with some observations on existing research.

To what extent do marginal tax rates matter for individual decisions to work and invest? The answer is essential for public policy and its role in shaping economic growth. The strand of the empirical literature that uses tax return data, surveyed in Saez, Slemrod and Giertz (2012), finds that incomes before taxes react only modestly to marginal tax rates and that the response is mostly situated at the very top of the income distribution.

So what does this mean? A lot depends on how one defines “modestly,” though it’s worth noting that even very small changes in growth – if sustained over time – can have big impacts on prosperity. Which, in turn, has a significant effect on government finances.

And I have no objection to the assertion that upper-income taxpayers are most sensitive to changes in tax rates. After all, people like me who rely on wage and salary income don’t have much opportunity to alter our compensation in response to changes in tax rates.

But upper-income taxpayers get most of their compensation in the form of business profits and investment returns, and this gives them substantial control over the timing, level, and composition of their income. So it’s quite understandable that their taxable income is quite sensitive to changes in tax rates.

That being said, Professor Mertens’ research suggests that conventional analysis has underestimated the impact of tax rates on the general population.

This paper adopts a macro-time series approach that addresses the endogeneity of average marginal tax rates in novel ways and permits insight into dynamics. Based on this approach, I find large income responses to marginal tax rates that extend across the income distribution. …The empirical results in this paper are relevant for several important debates. First, they reinforce the findings by a number of recent macro studies of large effects of aggregate tax changes on real GDP both in the US and internationally. The results imply that raising marginal tax rates to resolve budget deficits comes at a high price and that a proportional across-the-board tax cut provides successful stimulus that does not necessarily lead to greater income concentration at the top.

Interestingly, the first part of the last sentence helps to explain the very poor results of tax-heavy “austerity” packages in places such as Greece, Spain, Ireland, the United Kingdom, and Portugal.

Politicians in those countries are squeezing the private sector in hopes of minimizing the restraint imposed on bloated public sectors. But that doesn’t generate good results.

The Baltic nations took a much better approach, imposing genuine spending cuts the moment the crisis hit. Now their finances are in stronger shape and they’re enjoying renewed growth.

But I’m digressing. Let’s return to Professor Mertens’ research. He also produced some interesting results about tax rates and high-income taxpayers.

Many of the postwar tax reforms have made particularly large changes in top marginal tax rates. This variation in top statutory rates may be used to estimate the effects of a hypothetical tax reform that only alters marginal tax rates for the top 1%. …The specification…displays the response to a one percent rise in the net-of-tax rate of the top 1% in the income distribution. …The tax cut leads to significant increases in average top 1% incomes, which rise on impact by 0.52 percent and by 0.97 and 1.02 percent in the following two years, after which there is a gradual decline. …the cut in top 1% tax rates leads to a statistically significant increase in real GDP of up to 0.34 percent in the third year. …There are also spillover effects to incomes outside of the top 1%. Average incomes of the bottom 99% rise by 0.15 percent on impact and by up to 0.35 percent in the third year.

So we learn that lower tax rates for the “rich” are good for the economy and also beneficial for the living standards of the general population.

Why, then, would anybody want to impose high tax rates? Here’s a hint from the study.

Despite the spillover effects, a top marginal rate cut unambiguously leads to greater inequality in pre-tax income.

In other words, the rich get richer faster than the non-rich get richer when the top tax rate is reduced. So if you’re driven by class-warfare animus, you may decide that you’re willing to hurt poor and middle-class people in order to prevent upper-income taxpayers from realizing a bigger share of the economy’s increased output.

That doesn’t make much sense. But if you watch this video on class-warfare tax policy, there’s no logical reason to support higher tax rates on more successful taxpayers.

Unfortunately, politicians generally are motivated by a desire to maximize votes and power, not by what’s logical.

Which is why, when I’m doing educational outreach on Capitol Hill, I often make an extra effort to explain that a bigger economy – enabled by small government and free markets – is the same as a bigger tax base.

That’s far from a pure libertarian argument, to be sure, but it’s not easy when you’re trying to convince the foxes that it doesn’t make long-run sense to deplete the henhouse.

P.S. Notwithstanding all the academic evidence, there’s one group of people in Washington who deliberately assume that tax policy has no impact on economic output.

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